To successfully invest in digital assets, understanding what a crypto CFD is could be key.
Crypto CFD trading is very popular among investors as it allows them to profit from the price difference of cryptocurrencies without owning them. Moreover, investors won’t have to own a crypto wallet or an account on crypto exchanges to trade crypto coins. This will give them more trading opportunities.
With that in mind, in this guide, we’ll explain how to trade crypto CFDs and what are its main benefits and risks. We’ll also list the factors you need to consider before you start trading.
What Is Crypto CFD Trading?
CFD or Contract for Difference is an arrangement made in derivatives that includes using leverage. This means that investors can profit from the difference in crypto coin prices by opening short and long positions. This also means that investors will be able to use CFDs for both price speculation and risk hedging.
Since trading with CFDs includes leverage, investors must provide collateral to open and maintain their positions. However, compared to other types of crypto trading, these collaterals are much lower.
How does CFD trading work? After choosing the cryptocurrency in the form of CFDs and their position, investors will create a contract with a broker. These contracts will include the initial price for the position. The broker will pay the investors if the position is closed with a profit. However, the broker will charge the difference if the position is closed at a loss.
Main Components of CFD Trading
The three main components of CFD trading include:
- Volume of the deal
- Expiration time
Volume of the Deal
As mentioned before, investors must contract with brokers to conduct a CFD trade. This contract will try to reproduce crypto market conditions. This means that the volume of the deal will depend on the cryptocurrency being traded.
For example, crypto exchanges allow Bitcoin trading in decimals or whole parts. The same applies to the Forex exchange, where its CFD equivalent is traded; investors will need to create a CFD Bitcoin contract that will simulate BTC market conditions.
In short, if an investor wants to open a position that simulates buying 10 BTC, they will have to buy 10 BTC CFDs. The same applies to decimals — to open a position that simulates the purchase of 0.50 BTC, investors will have to buy 0.50 BTC CFDs.
Expiration time signifies the period between purchasing a CFD crypto contract and its sale. Once this period expires, the position will be automatically closed. The expiration date on most CFD crypto contracts is not fixed.
However, traders will need to use various trading strategies, such as hedging, to support their open positions. In addition to that, they’ll have to keep track of their plans. Why? Because CFDs that are not related to crypto assets come with an expiration date. This means that if investors want to hold their contracts for more days, they’ll have to pay fees.
The term spread refers to the difference in the buying and selling price of cryptocurrencies — the cost of opening a crypto CFD. That said, trading with CFDs includes the buy price, aka bid, and the sell price, aka ask.
This means that traders can open long and short positions. A long position refers to profiting from the difference in the purchase price of crypto coins. On the other hand, short positions allow traders to profit from the difference in the selling price of digital assets.
Remember that the selling spread will be slightly lower than the buying spread. However, the buying spread will also be slightly higher than the current market price of the selected cryptocurrency. Furthermore, ask and bid prices will be altered to match trading costs.
Benefits of Cryptocurrency Trading Through CFDs
The main benefits of CFD trading include the following:
Since CDF trading involves the use of margins — collaterals — investors will be able to earn larger profits by making smaller deposits. In other words, the CFD crypto leverage option will enable them to borrow funds from brokerage platforms.
For example, with $500, you can open a position worth $2,500 if it has a 5:1 leverage ratio. In addition, traders will benefit from both rising and falling crypto markets by opening long and short positions.
Since CFDs are considered derivatives, they are entirely legal. Moreover, all CFD trading platforms are licensed and regulated by financial institutions. This means they will implement strict security measures to protect their users from fraud and hacks.
Moreover, traders will be able to get their money back much more easily if certain security issues arise. CFD trading platforms will also impose different protection measures, from leverage limits to negative balance protection and market abuse prevention.
Advanced Technical Instruments
CFD trading includes the use of advanced technical tools, such as stop-loss orders. These orders help investors to manage risks and limit their potential losses.
For example, if you want to open a long position on an altcoin that shows great potential, you can set a stop-loss order lower than its current price. Let’s say the price of your preferred altcoin amounts to $100, and you set a stop-loss order of $90. Your position will be automatically closed if the altcoin price falls below $90. This means you’ll only lose only $10.
Liquidity refers to the speed at which cryptocurrencies can be converted into cash. That said, CFD trading offers higher liquidity compared to direct trading. Why? Because CFDs don’t need to be converted — all trades will be executed very quickly and for lower costs. Moreover, there are no daily cash-out limits, and traders won’t have to obtain a crypto wallet.
Risks Relating to Crypto CFDs
The main risks associated with trading with CFDs include:
Although leveraged trading enables investors to generate higher returns, it also comes with certain challenges. Higher leverage means higher chances of losing the initial capital. To reduce this risk, make sure to use lower leverage.
CFD trading involves paying multiple fees. For example, traders will have to pay a fee to open and close their positions, as well as extend them.
Lack of Variety
CFD trading offers less variety when it comes to cryptocurrencies that can be traded. With that in mind, unlike reputable crypto exchanges that offer altcoins, stablecoins, and meme coins, CFD brokers will have a limited list of available crypto coins and tokens.
How to Trade Cryptocurrency CFDs
Cryptocurrency CFDs always trade against traditional currencies, such as USD, EUR, and GBP. In the case of Bitcoin and the US dollar, CFDs will be marked as BTC/USD, BTC/EUR, and BTC/GBP. As mentioned before, their role is to enable investors to profit from price differences.
Other examples include:
- Ethereum against the US dollar: ETH/USD
- Ether against the Euro: ETH/EUR
- Litecoin against the US dollar: LTC/USD
- Litecoin against the Euro: LTC/EUR
That said, to trade cryptocurrency CFDs, you’ll have to:
- Pick a cryptocurrency you wish to trade
- Open an account on a CFD trading platform
- Choose your position
- Enter the number of CFDs you wish to trade
- Close your position
What to Consider Before Trading Crypto CFDs
Before starting with your trading activities, make sure to select a good and reliable crypto CFD broker. Good brokers will have an excellent track record and offer 24/7 customer support, as well as educational resources.
Another important thing to do before you start trading is to choose your trading strategy. On that note, you can test different strategies on accounts that offer a demo trading option. And finally, don’t forget to conduct an in-depth research of the crypto market. For example, pay attention to changes in the prices of crypto CFDs to identify their potential ups and downs.
What is a crypto CFD and why is trading with it beneficial? It offers traders a chance to make a big profit for a small initial investment. Moreover, CFDs don’t need to be converted. This means that all trades will take place relatively quickly.
However, CFDs also come with certain risks. On that note, traders will have to pay fees for opening and closing their positions. What’s more, CFD brokers have a much smaller list of available cryptocurrencies than crypto exchanges.